Transactions

REITs Pounce on Unstabilized Assets

In the past year, REITs have been the biggest buyers in the multifamily sector. Why? Partly because they’ve been incredibly effective at taking on empty projects that were former condos or brand-new complexes.

Consider Chicago-based Equity Residential, which bought the Dumont (later called 421 Mass) and Vantage Pointe in San Diego. Or Palo Alto, Calif.-based Essex Property Trust, which took down DuPont Lofts, in Irvine, Calif., and Essex Skyline at MacArthur Place.

“Non-stabilized deals don't qualify for agency financing, which weeds out a lot of potential buyers right out of the gate,” says Andrew J. McCulloch, an analyst for Green Street Advisors, a Newport Beach, Calif.-based consulting and research firm. “REITs have the ability to do all-cash deals using cash on balance sheet, lines of credit, or match fund purchases with new equity. Also, REITs likely have an advantage in how quickly they can lease these assets up given more advanced operating platforms.”

Just this week, Memphis-based Mid-America Apartment Communities announced that it bought the brand-new 1225 South Church Apartments in Charlotte, S.C. Earlier this year, it purchased Times Square at Craig Ranch in Dallas, which was about 50 percent leased-up on purchase. All told, Mid-America invested about $65 million on the two deals. “We have been very successful in acquiring unstabilized assets this year,” says Al Campbell, CFO of the company.

Campbell says REITs' balance sheet strength and improved operating platforms have allowed them to pounce on unstabilized deals. “The strength of the public REIT structure has really become evident in the recent market crisis, as REITs have emerged very strong with good access to low cost and flexible capital, both debt and equity,” he says. “This access to capital, combined with typically lower leverage levels, as compared to many private real estate companies, allows REITs to move quickly for deals and bear the upfront cost of the dilution for the future benefits.”

But for public companies, there is one small downside. New York-based Fitch Ratings, which is the smallest of the rating agencies, downgraded some REITs because their debt-to-EBIDTA ratio was elevated compared to prior levels.

“Equity, for example, bought vacant or near vacant assets this year, in particular in Washington, D.C., and San Diego,” says Steven Marks, managing director and head of Fitch Ratings U.S. REIT group. “While buying vacant assets doesn’t really affect a debt-to-book metric, it definitely affects a debt-to-EBIDTA metric. That was the primary reason for the sharp uptick in debt-to-EBIDTA. When we assume normalized occupancy for those properties, we still felt the debt leverage was too high for the rating category.”